Update #4

As of the end of April, the market has rebounded 29% from its March 23rd low, leaving the S&P 500 down 10% for the year. While the rally is a welcome reprieve, it seems to defy the gravitational pull of the economic and health crises that swirl below, which begs the question, “Is the worst behind us or ahead of us?” Are we poised to retest the market lows of March or revisit the market highs of February? Reputable professionals have differing views:

  • Jeffrey Gundlach, CEO of DoubLine, stated in an interview with CNBC, “I think a retest of the low is very plausible. People don’t understand the magnitude of…the social unease at least that’s going to happen when…26 million-plus people have lost their job.”

  • Brian Wesbury, Chief Economist of First Trust, stated in his newsletter, “We think the worst news is already factored in. Investors who can grit their teeth through the economic pain should be rewarded in the years ahead.”

It can be grueling for investors to navigate such uncertainty. Great angst can be created by the natural human desire to predict the inherently unknowable. Many will try. Some will get it right. Some will get it wrong. (And the next time around, the process will repeat with different winners and losers). The financial media will anoint the winners as prognosticating royalty; and others, afflicted with the foresight/hindsight bias, will emerge trumpeting that the outcome was so obvious, “they knew it all along too.”

The truth is that no one knows. Significant headwinds and tailwinds are at play, pushing and pulling in an environment without precedent. The pace of change makes even the simple act of writing a timely and meaningful letter to clients a challenging endeavor. By the time you read this, the prevailing winds may very well have shifted again.

We are neither fortune tellers nor speculators; rather, we develop our professional opinion based on fundamental analysis and our decades of experience, and we advise our clients accordingly. We focus steadfastly on the long-term, while allowing for some flexibility to make marginal adjustments based on our assessment of risk and return.

Our current opinion, which we offer with a suitable dose of caution and humility, is that the probability of a market pullback is greater than the probability of reaching new market highs and that the magnitude of the potential pullback is greater than the potential upside over the near term. We continue to be comfortable positioning accounts towards the conservative end of their long-term targets while finding opportunities to purchase investments that look attractive along the way.

For now, here are some of the more notable forces that are influencing our opinion of the market:

PANDEMIC (Headwind)

  • The novel coronavirus COVID-19 has led to an unprecedented shutdown of economic activity.

  • New cases of COVID-19 continue to grow across the globe, but efforts to “flatten the curve” appear to be working as the number of new cases in the U.S. levelled off in April.

  • How the virus will playout from here is a source of great uncertainty. The virus could fizzle out on its own (a possibility, but seemingly unlikely); new treatments and a quickly discovered vaccine could enable us to get back to normal sooner rather than later (a hopefully more likely outcome); or repeated waves of the virus could weigh on the world’s psyche and ability to carry out economic activity as usual for the next 18 to 24 months until the virus naturally runs its course and herd immunity is reached (a non-trivial probability).

ECONOMY (Headwind)

  • The economy created 22 million jobs over the last 11 years. 30 million jobs have now been lost in the last six weeks.

  • GDP contracted at an annualized rate of 4.8% in the first quarter (the worst since the financial crisis) and is expected to contract in the second quarter at the steepest pace since 1930s (perhaps as much as 30% annualized) and slowly recover from there.

  • Consumer spending, which accounts for 70% of GDP, dropped at an annualized rate of 7.6% in the first quarter.


  • While valuations have come down since February, stocks are generally still not cheap with market valuations above their long-run averages. The S&P 500 is trading around 18 times trailing earnings, and likely at least 21 times earnings for this year. The Shiller P/E or CAPE ratio (which reflects price relative to cyclically adjusted 10-year earnings) is around 26.

  • S&P 500 dividends are expected to fall 23% in 2020. 30 companies have already suspended their dividends according to Goldman Sachs.

  • Consensus estimates for operating earnings of S&P 500 companies forecast that earnings will decline 13.4% in 2020 and then bounce back 25.6% in 2021 to above the level of profits reached in 2019 (source: Standard & Poors 4/23/20). During the three most recent recessions, the operating earnings of S&P 500 companies declined by 24.4%, 31.6% and 56.5%, and typically required a couple of years to return to pre-recession levels.


Unprecedented steps have been taken to combat the stalled economic engine:

  • The Fed Funds target has been lowered to 0%.

  • Fed’s Balance Sheet has expanded to over $6 trillion from its recent low of $3.7 trillion. Estimates suggest it could grow to $9-$11 trillion as the Fed continues to provide much needed liquidity to critical markets.

  • The US Treasury has launched a $2.7 trillion relief package that includes checks to individuals, forgivable payroll protection loans to small businesses, and other economic injury loans. Congress may pass additional fiscal stimulus in the months to come.

  • A headwind that will be created from the massive stimulus package is a budget deficit that is on pace to exceed 15% of GDP, levels not seen since World War II. The long-run effects of the unprecedented level of monetary and fiscal stimulus are a significant unknown.


  • Oversupply and demand shock continue to depress the price of oil to record lows (even breaking into negative territory at one point) – a black swan event in its own right.

  • The “breadth” of the market is fairly weak, meaning the market leadership is narrow. In general, as goes big tech, so go the major stock market averages.

  • The top 20 stocks in the S&P 500 have accounted for 35% of the rally according to Goldman Sachs research.

  • Microsoft, Apple, Amazon and Google are each individually larger than the entire Energy sector. Throw Facebook and Netflix in the mix and these six juggernauts represent 20% of the S&P 500 (and 45% of the Nasdaq Composite). They account for the same percentage of the S&P 500 index as the bottom 360 names.

The net result of the swirling winds of the economy, market and pandemic is a stock market, as measured by the S&P 500, trading at roughly the same level it was just six months ago when the outlook was far rosier and seemingly less uncertain. The market thus appears to be pricing in a best-case scenario at this point. Despite our near-term caution, we remain resolute in our belief that over the long-term the compounding power of equity and the resiliency of our country will reward investors. We will be vigilant and continue to scour the marketplace for value. We will continue to buy when we see opportunity and encourage conservatism in the meantime.

Thank you as always for your trust and confidence in us. We are here for you, so please do not hesitate to give us a call or shoot us an email.


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